When starting a business, choosing the right structure is important. It is the foundation of the business and determines a lot of things like how the business operates, how it’s taxed, if its shares can be traded publicly or not, the number of business owners the business can have, who bears the risks and obligations of the business and so on.
Each business structure has its pros and cons, and in this post, we’ll be examining both. At the end, you’d be able to decide which structure is best suited for your business.
THE DIFFERENT BUSINESS STRUCTURES.
Let’s examine the business structures so you can have an idea of which is best suited for your business.
Sole proprietorship or Proprietorship: This business is owned by one person, called the sole proprietor or proprietor. The sole proprietorship is a common type of business.
It is unincorporated and is usually a small business. The sole proprietorship is the same as its owner. This means that the profits made in the business are not taxed differently from the owner’s income.
The owner provides all the capital for running the business alone or may borrow from family or friends.
The sole proprietor makes all the management decisions and bears all risks and obligations of the business and so the proprietor has unlimited liability.
Sole proprietorships have a minimal amount of legal formalities and so they are the easiest business type to set up.
Also, because proprietors bear all the risks alone, they enjoy all the profits alone. But what happens when the proprietor travels, is sick or worse still, dies? Unfortunately, the business perishes with the owner. Choosing a proprietorship has some pros and cons which are stated below.
Pros of the sole proprietorship
It is easy to set up.
The proprietor owns all the profits.
It’s easy to control the business.
The proprietor chooses when, how and where he wants to operate.
The proprietor has direct contact with his customers.
Taxes are not as high as the owner is taxed only once.
Decision making is fast and easy.
Cons of the sole proprietorship
The proprietorship has unlimited liability.
It lacks continuity.
It’s somewhat hard to get capital for running the business.
Lack of assistance leads to stress on the proprietor.
Work may get monotonous.
Keeping up with the larger competition is hard.
Decisions of the owners are not reviewed by anyone else; this could lead to bad decisions being made.
The costs of running the proprietorship can be high.
Partnership: A partnership is owned by two or more people who are partners. Here, there’s more than one owner so this means that there are more investments in the business and the business profits are shared between more people based on the percentage of capital they have invested into the business.
The partnership is guided by an agreement called the “Deed of Partnership”. The partnership is also an unincorporated business and it lacks limited liability so the partners bear all risks and liabilities.
In a partnership, taxes are not paid on income earned, but profits and losses are passed down to each of the partners.
Partnerships don’t have to be strictly individuals; they may be other business entities. Partnerships could be of different sizes; small, medium or large and are common in accounting and law. Partnerships are a bit risky. This is because each partner is liable for the partnership’s debts. But there’s a remedy for this called LLPs which limit claims against partners to the assets they have in the business. Also, some partners can have limited liability.
Pros of partnership
Partnerships are easy to form.
More capital is available to the business from partners.
Partners can participate in decision making.
It is less stressful on the partners because they work together and not alone.
Taxation is often not expensive just like the sole proprietorship.
Cons of partnership
The partnership has unlimited liability. (excluding LLPs)
Profits are shared.
The partnership lacks continuity just like the proprietorship.
The decision of one partner affects all partners and they all bear the risks.
Decisions are also more time consuming and harder to make.
Corporations: A corporation is an incorporated business owned by shareholders in the company. The shares they hold represent a portion of the corporation which they own.
The more shares you have, the more of the business you own. Corporations have limited liability and therefore, this reduces risks to shareholders. A corporation is also a separate entity from its owners.
There are two basic types of corporations. The C corporation and the S corporation. In the C corporation, shareholders are taxed separately from the corporation itself. The taxes are charged on the profits of the business.
An issue in the C corporation is double taxation: the corporation pays income taxes and the shareholders are also taxed on their dividends.
However, in the S corporation, taxes flow-through to the shareholders and double taxation is avoided. Still, one downside of the S corporation is that it has a maximum of 100 shareholders.
Pros of a Corporation.
Owners have limited liability.
The business is a separate entity from its owners.
Raising capital is easier.
There is room for more professional management.
Cons of a Corporation.
There is double taxation in the C corporation.
In the S corporation, there’s a maximum of 100 shareholders.
Decision making becomes even slower and complex.
Limited Companies: A limited company is a corporate entity that limits the shareholder’s liabilities to the assets they have invested in the business. The limited company is separate from its owners; it is a separate entity (unlike the proprietorships and partnerships).
If a Limited Company becomes bankrupt, its creditors don’t have a claim on the personal property of the shareholders. We’ll talk about a few variations of limited companies.
Private Limited Company (LTD): This is a corporate structure that has limited liability and therefore, the risks of shareholders are limited to their investment in the business. Private Limited Companies (LTDs) cannot sell shares to the general public but shares can be transferred to other people with the consent of other shareholders which are often a maximum of 50. So, we can say that capital sources are still a bit limited. The Private Limited Company is a separate legal entity from its shareholders and both are taxed separately. After taxation, some of the after-tax income is distributed to shareholders as dividends the rest is retained for the company’s day to day activities. It is important to remember that the company’s finances are different from the personal finances of its owners.
Public Limited Company (PLCs): A Public Liability Company is a corporate structure that just like the LTD, has limited liability.
The PLC can offer its shares to the public in the stock exchange market. This allows the PLC to raise large sums of money for its operations.
PLCs are required to publish certain financial records for the use of investors or other stakeholders of the business.
The shareholders in the PLC elect a board of directors who in turn, elect a chairperson known as the Chief Executive Officer (CEO) and PLCs are required to hold annual general meetings (AGMs). The death of any party in the PLC does not lead to its termination and so the PLC can be said to have continuity. Usually, the PLC consists of a minimum of seven people but there’s no maximum number attached.
Limited Liability Company (LLCs): The Limited Liability Company is a business structure in the United States that combines the taxation system of the sole proprietorship with a corporation’s limited liability.
The LLC can choose how it prefers to be taxed; it can be taxed as a sole proprietorship, as a partnership, or even as a corporation by filing the right forms. The LLC is very flexible as it combines both business structures. The LLC is not under state or provincial law.
The owners of the LLC are referred to as members and not shareholders and claims to assets in the LLC are called membership interest instead of shares. Forming an LLC is not as tedious and demanding as forming a corporation and the LLC is a separate legal entity from its members and offers them protection.
Limited Liability Partnership (LLP): The Limited Liability Partnership (LLP) is a partnership that protects each partner from the risks, obligations, and consequences of the bad decisions of other partners this is to say that it also offers limited liability. Professionals like accountants and lawyers use the LLP structure as it helps save costs, reduces risks and creates room for growth. In an LLP the business is taxed like a partnership.
Taking your time to digest all the information on this post and making comparisons between them will help you tremendously in choosing what business structure is best for you.
Don’t hesitate to get advising from professionals around you and also, make necessary inquiries.
Did we miss anything out? Feel free to comment below.
Esther Alu, the Founder of TheAceBusiness.com is an entrepreneur who writes step-by-step guides for starting several business ideas. She is constantly learning and discovering effective ways to help her readers launch and grow successful businesses.